lEaRnInG FRoM tHE Past to sHaPE tHE FutuRE

Our View This is the twelfth edition of VIEW and it provides a timely opportunity to review the underlying theme and key messages set out in the leading articles. The common theme has been the raw material resource challenge that continues to face food companies. The challenge arises from a wide range of critical uncertainties based on the juxtaposition of the expectation of a continued expansion of global demand and potential supply bottlenecks for raw materials. EFFP, as evidenced by its VIEW articles, can fairly lay claim to an early appreciation of the implications of this challenge for food companies and it has sought to translate its study of the issues into strategic responses via key messages published in VIEW and through our work with food companies and farmers.

04/05 VIEW Magazine

The first issue in 2008 coincided with UK feed wheat prices – a good harbinger of agricultural prices in general – rising sharply to just over £178 per tonne. Brief periods of price volatility are not uncommon in the food industry and following the 1990s where cereal prices were characterised by a declining trend and low volatility an increase might reasonably have been expected. But our analysis of the underlying forces suggested that this was no short-term spike. Rather it marked the beginning of a new era in which high and volatile agricultural prices would be sustained; indeed UK feed wheat prices currently stand at £195 per tonne. Figure 1 draws on FAO data to show that at the global level since 2007 on average, cereal prices have been more than 50 per cent higher than in the previous ten years and volatility has more than doubled.

As indicated higher and more volatile raw material prices are the product of three longer term trends: rapidly rising living standards in the world’s highly populated, emerging countries; growing restrictions on the ability of farming to increase the area of agricultural land and its productivity; and climate change. As recent events have shown, set against these trends relatively small changes or ‘shocks’ to the system lead not only to sharp changes in the prices of raw materials but also to uncertainty associated with the security of supply. For example, the Russian and Argentinian export bans in 2009 and 2010, the uncertainty created by regulations in the areas of pesticides and poultry systems, the confidence sapping effects of e.coli outbreaks and the discovery of horsemeat in beef products, as well as the impact of more frequent extreme weather patterns. Figure 2 attempts to capture the impact of the longer term trends now governing the supply of agricultural raw materials for food companies. Our key message is that responding to the reduced security, greater volatility and the reputational damage associated with higher raw material prices is one of the most urgent challenges facing food businesses.

KEY MESSAGES

Points A, B and C in Figure 2 show how the three challenges interact. Point A reflects the fact that as supply struggles to keep pace with demand, any adverse influence, actual or perceived, in the delicate balance of demand and supply increases the uncertainty associated with security of supply and greater volatility. Point B captures the reputational damage that large raw material price fluctuations can generate from the tensions that arise with suppliers and customers. Point C signals the reputational risks of responding to growing insecurity by sourcing from new suppliers (including overseas) where systems and controls are necessarily harder to check as recent events have demonstrated. Point D is the fulcrum; it reveals that a business level strategic response must be capable of dealing simultaneously with the three key challenges.

Issue 12/Summer 2013

FIG 1: GlOBAl CEREAl PRICES FIG 2: ThREE KEy ChAllENGES

200

150

175

125

100

50

0

25

75

Index

World cereal prices1997–2006 (crop years)

World cereal prices2007–2016 (crop years)

Range within which prices have fallen 90% of the time

Average price over the period

D

B

A C

Reduced raw material supply

security

Increased volatility of

raw material prices

Reputation risks from

new sources of supply

50%HIGHER GloBal CEREal PRICEs sInCE 2007

06/07 VIEW Magazine

FoodInFlatIon

Issue 12/Summer 2013

Before looking in more detail at the strategic response EFFP has crafted and set out in the editions of VIEW it is appropriate to recall that higher and more volatile raw material prices also have adverse consequences for consumers. A major consequence of the 2008 spike in raw material prices was to raise retail food inflation to an unprecedented 12.8 per cent. EFFP not only correctly forecast that the index would decline sharply from this peak in the following months but also it was in the vanguard of spotting that for consumers, the new era would witness a reverse of food prices rising more slowly than prices generally and consequently there would be a deterioration in the affordability of food: see Figure 3.

Prior to the financial crash in 2009 we expected that the deterioration in the affordability of food would result in a consumer flight from premium towards value products. At the onset of the financial crash we anticipated that UK food processors and manufacturers of food would suffer less than other industries in the ensuing downturn – see Figure 4 – and it looked at the time like a classic, if deep, recession that would be followed after several months by recovery. In the event the recession has proved stubborn and the combination of recession – low wage increases, increased unemployment – and higher retail food prices has effectively flat-lined consumers’ expenditure on food and non-alcoholic drinks after allowing for inflation – see Figure 5 – very much reinforcing our warnings on the affordability of food.

105

100

95

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Index

2006 2007 2008 2009 2010 2011 2012 2013EFFP index of food affordability (food prices relative to consumers’ expenditure)

Lessaffordable

115

100

105

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95

90

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Index

20022000 2004 2006 2008 2010 2012

Source: Office for National Statistics

Production of foodTotal Industrial production

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20001998 2002 2004 2006 2008 2010 2012

Source: Office for National Statistics

Consumers’ expenditure on food and non-alcoholic drinksafter allowing for inflation

FIG 3: ThE AFFORDABIlITy OF FOOD

FIG 4: COMPARATIVE INDUSTRIAl PRODUCTION

FIG 5: REAl CONSUMERS ExPENDITURE

12.8%UNPRECEDENTED RISE IN RETAIl FOOD INFlATION AS A RESUlT OF ThE 2008 SPIKE IN RAW MATERIAl PRICES.

08/09 VIEW Magazine

tHE stRatEGIC REsPonsE

Issue 12/Summer 2013

EFFP has argued consistently that the new business environment outlined above was going to dictate a more strategic approach towards the procurement of raw materials by food companies – essential point D in Figure 2. We identified that this new approach would need to be founded upon stronger upstream supply relationships involving, as appropriate, a new emphasis on the involvement of farmer groups. As a first step towards helping senior managers embrace the logic of this new, collaborative philosophy involving raw material suppliers we developed the strategic model set out in Figure 6. It shows a strategic relationship map which is designed to help senior managers relate strategy formulation to the external business environment – a formulation that necessarily involves longer term strategic procurement relationships as opposed to day-to-day tactics. A comparison of the lower horizontal axis of Figure 6 and the experience of the series of ‘shocks’ that have significantly increased the risks associated with the volatility and uncertainty of supply over the last four years is sobering.

Despite the stubbornness of the recession, which understandably focuses senior management attention on the short-term, these longer term, external influences should be moving food company strategists towards at least point A in Figure 6. looking forward the recession will ease and as confidence and consumers’ expenditure recover we contend that food companies, seeking to achieve sustainable, competitive advantage, will need to weigh the benefits of moving more in the direction of point B, and even further in the same direction if supplying high value niche markets. Building on the strategic relationship map we have outlined a scenario model for food companies – see Figure 7 – to help weight alternative futures. The futures summarised in the figure are only illustrative but such an exercise has an important role in the process of strategy formulation.

Highvalueniche

Spotmarkettransaction

Non-feasible

Non-feasible

Longertermrelationship

Informationsharingrelationship

Integrateddecisionrelationship

Plentifulsupply

Volatilesupply

Uncertainsupply

Vulnerablesupply

Assured attributes

Preferred supplier

Minimum standard

A

B

Hig

h an

d m

ore

vola

tile

agr

icul

tura

l pri

ces

Lower and m

ore stable agricultural prices

Permanent lossof GDP

Recoupment oflost GDP

Economy grows slowly,as does consumer expenditure and when combined with food inflation forces companies to focus heavily on value products

Economy grows slowly, as does consumer expenditure but scope for companies to supply premium innovative products to discerning consumers

Economy grows strongly, consumer expenditure recovers but food is constrained by inflation and hence greater demand for value andaffordable prices

Economy grows strongly, consumer expenditure recovers rapidly creating enhanced demand for innovative products that companies can supply at affordable prices

FIG 6: A STRATEGIC RElATIONShIP MAP FIG 7: AlTERNATIVE FUTURES

Food service

Retailers

Manufacturers

Processors

Farmers

10/11 VIEW Magazine

As the recovery of consumers’ expenditure has repeatedly failed to materialise so food companies have found themselves caught in the pincers of lacklustre demand and the growing challenge of sustainably sourcing their raw materials.

Mutual dependency

Supply chain integration

Com

mer

cial

ben

efit

s

Start point

A Improve chain

com

munication

B Regular forums to

build trust and loyalty

C Create systems for

sharing information

D Guarantee markets for specific investments

E Develop evaluation

procedures

F Comm

itment

to

continuous

im

provem

ent

G A

lignm

ent w

ith

pe

rcei

ved

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e

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iew

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ated

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obje

ctiv

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nd p

lans

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N

and join

t stra

tegy

Fair sharing of

M

the value created

Seek opportunities Lfrom new capabilities

Measure key

K

performance indicators

Shared rewards for

J

successful innovation

Sharing of both

I

decisions and risk

Sustainablecompetitiveadvantage

FIG 8: ACTIONS FOR INTEGRATION

Issue 12/Summer 2013

Prior to 2008, after many years of growing affluence and the seeking of new food experiences by consumers, it was not surprising that new product development was the prime focus for food companies in the search for value. But as the recovery of consumers’ expenditure has repeatedly failed to materialise so food companies have found themselves caught in the pincers of lacklustre demand and the growing challenge of sustainably sourcing their raw materials. Despite the lack of growth we see opportunities in both the short and longer term for food companies. Figure 9 shows EFFP thinking regarding the framework for a transformational business approach for food companies. We have long held to the view that domestic sourcing is capable of unlocking millions, if not billions of pounds of value within a more collaborative, longer visioned food chain that devotes as much attention to the sources of its raw materials supply as it has to new product development. Indeed, we do not believe that progress can be made in unlocking upstream value and improving sustainability if food companies insist on a business as usual approach.

Against the changing external environment outlined, food companies seeking sustainable competitive advantage must attach heightened importance to building longer term upstream collaborative relationships with raw material suppliers. To aid this process EFFP has developed the model set out in Figure 8. The raw material supplier may be a processor, a merchant, a farmers’ group or even a single farm (albeit large scale) but, as made clear in the figure, three critical ingredients are necessary to deliver sustainable competitive advantage. Firstly, there must be mutual dependency based on specific attributes eg production systems, breeds. Secondly, both buyer and seller must equitably share the decisions and the risks of closer integration eg investment in continuous improvements and thirdly, there must be a fairness in the distribution of the delivered commercial benefits. EFFP’s involvement with some of the food industry’s leading players has demonstrated how these steps can create and capture value for all partners via lower costs, reduced risks and new product development.

The logic of EFFP’s analysis of the strategic opportunities lying upstream in the food chain was reinforced by the sharp depreciation in sterling prompted by the financial crash. We have repeatedly argued that this realignment of the currency after many years of over-valuation presented the food industry with an opportunity to increase exports and improve the UK’s food trade balance. The more so in a world in which not only were per capita incomes in the developing world growing steadily but also the rapid urbanisation of populations in these countries was greatly increasing demand for processed and convenience foods. Realising new opportunities always necessitates investment and as EFFP’s surveys of food industry investment intentions has revealed, despite the reverberations of the financial crash it is not finance that is the limiting factor. The key influence appears to be confidence in market demand and an ability to compete.

Stuck-in- the-middle

unable to identify and seize

opportunitiesShort-termvalue seeking.

No commitmentto longer term improvement

Opportunitiesto create longer

term sustainable value from raw

materials

Collaboration

AutonomyTa

ctic

al

Strategic

FIG 9: TRANSFORMATIONAl RElATIONShIPS

12/13 VIEW Magazine

aB C

The future resource challenge facing the food industry has been set out in great detail in the Government’s Office for Science publication of The Future of Food and Farming. The report reinforced EFFP’s approach warning of the challenges the industry faces in obtaining a sufficient supply of raw materials to meet demand. The report emphasised the need to keep pace with scientific and technological advances – to which we would add also intra- and inter-organisational management advances – and the heightened risks of relying on global markets for key raw materials. We believe there are lessons for the food industry in the experience of the UK car industry in 1970s. The car industry’s difficulties arose from a failure to fully appreciate the significance of a changing global environment and in particular the increasing competitive advantage from international firms who had recognised the importance of a whole supply chain approach to business success.

Issue 12/Summer 2013

The Government’s report was only one of a number of studies pointing out the implications of the growing resource challenge and in particular the issue of sustainability. Environmental factors, especially climate change, are creating increasing uncertainties regarding the patterns of production for key raw materials. Water and agricultural land are already scarce in many parts of the world, and are coming under pressure from competing uses such as urbanisation and industrial development. Summarised by the concept of the triple bottom line, sustainability has been rising up the agenda in many Board rooms, a fact confirmed by an EFFP survey of food industry leaders. The challenge of sustainability and the food industry’s raw material resource challenge are ultimately the same issue and this is recognised in EFFP’s model which takes as its starting point the triple bottom line but places economic sustainability in the position of primus inter pares. The essence is captured in Figure 10. The widely held belief that there is a trade-off between improving shareholder value by focusing on economic sustainability and delivering greater ecological and social sustainability is represented by a move from A to B. This belief is challenged in the EFFP model which offers food companies the prospect of moving from A in the direction of C by the development of a raw material strategy.

At the heart of the EFFP’s sustainable business model is the alignment of productivity growth at the raw material stage with dedicated downstream customers. The challenge is to increase the production of raw materials while reducing inputs of water, energy and land per unit of output. We believe there are enormous economic gains for a food chain whose strategic intent is not to trim ambitions to match existing resources (so called strategic fit) but to leverage raw material resources to compete sustainably in innovative ways. EFFP’s experience and knowledge has given rise to the belief that significant potential gain resides at the raw material stage and if this can be can be released the benefits will flow down the chain to enhance a firm’s products and value. In its approach EFFP seeks to fundamentally alter the terms of engagement with raw material suppliers and thereby to outpace competitors by transparently enhancing all aspects of sustainability through collaboration.

Economic sustainability(shareholder value)

Ecological andsocial sustainability

A

C

B

FIG 10: A RAW MATERIAl APPROACh TO SUSTAINABIlITy

We believe there are enormous economic gains for a food chain whose strategic intent is not to trim ambitions to match existing resources (so called strategic fit) but to leverage raw material resources to compete sustainably in innovative ways

14/15 VIEW Magazine

Inte

rnal Partner

External

Capturing new knowledge relating not only to the sustainable growing of food but also to changing consumer demands and improvements in internal and intra-organisational relationships

Capturing thelearning from the firm’s experience to develop capabilities involving routines and systems, reduced waste, shared information and innovative activities

Capturing thelearning from supply chain collaboration to jointly develop shared capabilities to reduce waste, to better align planning and share investment risks in innovative activities

Newknowledgecapital and

management

The essence of EFFP’s sustainable business model is shown in Figure 11 and is founded upon a collaborative relationship not with the single purpose of providing improved security but rather as a joint venture in the development and management of internally generated new knowledge. The figure indicates that if this learning is captured in the form of knowledge it can be leveraged via the four channels illustrated. Of critical importance is investment to reinforce the development of shared capabilities and by jointly agreeing and tracking these investments both buyers and sellers can ensure that they are congruent and thereby a source of additional value. Adherence to an agreed strategic intent and detailed plans ensures the closer alignment with market intelligence which not only reinforces all aspects of sustainability but also creates additional value. It is the consistency between the strategic

Production technologySustainable systems

Seller Collaborative relationships

Development and management of new knowledge

Buyer Production technologyMarketing intelligence

Integrated planningFaster response timeImproved price and quality control

Smarter investmentBetter alignment Risk managementSuperior efficiency

Process innovationReduced wasteIntegrated planning

Process assuranceFinancial securityEnhanced reputation

Reinforced capabilitiesImproved returnsJoint investment opportunities

FIG 11: A RAW MATERIAl APPROACh TO SUSTAINABIlITy

FIG 12: COllABORATIVE CONTRIBUTORS TO KNOWlEDGE CAPITAl

£and operational activities of both buyers and sellers that generates the competitive advantage and thereby greater shareholder value.

The new knowledge comes from a variety of sources but of particular interest is that generated by the learning arising from a joint commitment to collaborating in order to leverage multi-dimensional advantages; see Figure 12. As a partner each enterprise brings the learning it has gained from its business activities and unique experiences as well as its interpretation of external events and their potential impact. In addition, the partners learn from their sharing of information and activities. It is the bringing together of these alternative interpretations and experiences that potentially provide a rich source of joint learning which in turn offers scope to create heterogeneous opportunities for competitive advantage.

Issue 12/Summer 2013Issue 12/Summer 2013

ConCludInG tHouGHts

The longer term outlook has not materially changed since the first edition of VIEW. For UK food companies the short term has been dominated by the continuing recession and this has understandably tended to focus managers on tactics rather than longer term strategy. This approach gives rise to an over emphasis on cost and value while playing down, or ignoring, the longer term threat to value creation from developments in raw material markets. A threat that has been clearly identified and must now be made the focal point for the survival and success of food companies.